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the limits imposed on household choices by income, wealth, and product prices

I = Px • Qx + Py • Qy

if I increases - outward parallel shift

if Px increases - inward rotation in BC

if Px decreases - outward rotation in BC

choice set/opportunity set

the set of options that is defined and limited by a budget constraint

(area underneath budget constraint line in graph)

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real income

the set of opportunities to purchase real goods and services available to a household as determined by prices and money income

utility

the satisfaction a product yields

marginal utility

the additional satisfaction gained by the consumption or use of one more unit of a good or service

MU = ΔTU/ΔQx

total utility

the total amount of satisfaction obtained from consumption of a good or service

law of diminishing marginal utility

the more of any one good consumed in a given period, the less satisfaction (utility) generated by consuming each additional (marginal) unit of the same good.

utility-maximizing rule

equating the ratio of the marginal utility of a good to its price for all goods

diamond/water paradox

a paradox stating that 1) the things with the greatest value in use frequently have little or no value in exchange and 2) the things with the greatest value in exchange frequently have litter or no value in use.

income effect

change in Qx demanded that is attributable to the welfare change that accompanies the price change

-feel you have higher income so you buy more (if normal good) and price is lower

(qx2 – qx')

diff bw E2 and E' in graph

substitution effect

change in Qx demanded when Px changes and consumer utility is kept constant

(qx' – qx1)

difference between E1 and E' in graph

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labor supply curve

a curve that shows the quantity of labor supplied at different wage rates. its shape depends on how households react to changes in the wage rate.

financial capital market

the complex set of institutions in which suppliers of capital (households that save) and the demand for capital (firms wanting to invest) interact.

production

process where inputs are combined and turned into outputs

firm

an organization that comes into being when a person or a group of people decides to produce a good or service to meet a perceived demand

profit

-the difference between total revenue and total cost

- TP = (AR – AC)•Q* ---> if you add more to cost than to revenue, profit decreases

total revenue

the amount received from the sale of the product (q • P)

total cost

the total of 1) out of pocket costs and 2) opportunity cost of all factors of production

= out of pocket costs + normal rate of return on capital + opp. cost of each factor of prod.

normal rate of return

a rate of return on capital that is just sufficient to keep owners and investors satisfied. for relatively risk-free firms, it should be nearly the same as the interest rate on risk-free government bonds

short run

the period of time for which two conditions hold: the firm is operating under a fixed scale (fixed factor) of production and firms can neither enter nor exit an industry

long run

that period of time for which there are no fixed factors of production: firms can increase or decrease the scale of operation and new firms can enter and existing firms can exit the industry

optimal method of production

the production method that minimizes cost

production technology

the quantitative relationship between inputs and outputs

labor-intensive technology

technology that relies heavily on human labor instead of capital

capital-intensive technology

technology that relies heavily on capital instead of human labor

production function

a numerical or mathematical expression of a relationship between inputs and outputs. it shows units of total product as a function of units of inputs.

marginal product

the additional output that can be produced by adding one more unit of a specific input, ceteris paribus.

law of diminishing returns

when additional units of a variable input are added to fixed inputs, after a certain point, the marginal product of the variable input declines.

average product

the average amount produced by each unit of a variable factor of production

TP

QL

fixed cost

any cost that does not depend on the firms' level of output. these costs are incurred even if the firm is producing nothing. there are no fixed costs in the long run

variable cost

a cost that depends on the level of production chosen

total cost

variable costs + fixed costs

total fixed costs

the total of all costs that do not change with output even if output is zero

average fixed cost

total fixed cost divided by the number of units of output; a per-unit measure of fixed costs

TFC/Q

spreading overhead

the process of dividing total fixed costs by more units of output. average fixed cost declines as quantity rises

total variable cost

the total of all costs that vary with output in the short run

total variable cost curve

a grave that shows the relationship between total variable cost and the level of a firm's output

marginal cost

the increase in total cost that results from producing one more unit of output. marginal costs reflect changes in variable costs

TVC↑ amount

average variable cost

total variable cost divided by the number of units of output

TVC/Q

average total cost

total cost divided by the number of units of output

TC/Q

perfect competition

-many firms, small rel. to industry

-producing identical products

-no firm is large enough to have control over prices

-free entry and exit to industry (no barriers)

-individ. firms are price takers

homogeneous products

undifferentiated products, products that are identical to, or indistinguishable from, one another

marginal revenue

the additional revenue that a firm takes in when it increases output by one additional unit. in perfect competition, P = MR

breaking even

the situation in which a firm is earning exactly a normal rate of return

shutdown point

the lowest point on the AVC curve. when price falls below the min. point on AVC, total revenue is insufficient to cover variable costs and the firm will shut down and bear loses equal to and below fixed costs

short-run industry supply curve

the sum of the marginal cost cures (above AVC) of all the firms in an industry

increasing returns to scale (economies of scale)

an increase in a firm's scale of production leads to lower costs per unit produced

ex: roommates splitting rent, 50 people on a bus instead of 50 people driving cars, assembly line

LRAC ↓

as Qinput ↑, Qoutput ↑ by more

constant returns to scale

an increase in a firm's scale of production has no effect on costs per unit produced

LRAC has horizontal slope

decreasing returns to scale (diseconomies of scale)

an increase in a firm's scale of production leads to higher costs per unit produced

LRAC ↑

as Qinput ↑, Qoutput ↑ by less

optimal scale of plant

the scale of plant that minimizes average cost

long-run competitive equilibrium

when P = SRMC = SRAC = LRAC and profits are zero

derived demand

the demand for resources (inputs) that is dependent on the demand for the outputs those resources can be used to produce

productivity of an input

the amount of output produced per unit of that input

marginal product of labor (MPL)

the additional output produced by one additional unit of labor

marginal revenue product (MRP)

the additional revenue a firm earns by employing one additional unit of input

MRPL = MPL • PX

what additional employee is work to firm

revenue they will bring in

factor substitution effect

the tendency of firms to substitute away from a factor whose price has risen and toward a factor whose price has fallen

if Pk increases, then K decreases (hire less) less of complementary inputs but ^ demand for subs. inputs

output effect of a factor price increase (decrease)

when a firm decreases (increases) its output in response to a factor price increase (decrease), this decreases (increases) the demand for all factors

with higher costs (Pk) - produce less output - use less of all inputs

demand-determined price

the price of a good that is in fixed supply; it is determined exclusively by what households and firms are willing to pay for the good

pure rent

the return to any factor of production that is in fixed supply

technological change

the introduction of new methods of production or new products intended to increase the productivity of existing inputs or to raise marginal products

shifts in input demand

1) technological change

2) price increase/demand increase

3) change in the quantity of other inputs

4) change in price of other inputs

partial equilibrium analysis

the process of examining the equil. conditions in individual markets and for households and firms separately

-only working in one market (equilibrium in individual markets)

general equilibrium

the condition that exists when all markets in an economy are in simultaneous equilibrium

-equilibrium in optimization in all markets at same time

efficiency

the condition in which the economy is producing what people want at least possible cost

pareto efficiency or pareto optimality

a condition in which no change is possible that will make some members of society better off without making some other members of society worse off

market failure

occurs when resources are misallocated or allocated inefficiently. the result is waste or lost value

public goods or social goods

goods and services that bestow collective benefits on members of society. generally, no one can be excluded from enjoying their benefits.

ex - national defense

externality

a cost or benefit imposed or bestowed on an individual or a group that is outside, or external to, the transaction

imperfect information

the absence of full knowledge concerning product characteristics, available prices and so on.

consumer equilibrium

MUx= Px

MUy Py

when the BC is tangent to indifference curve

Marginal rate of substitution

rate at which consumer is willing to substitute good x for good y

MUx = Px = MRS

MUy Py <---------***in equilibrium**

price effect

qx2 – qx1 = substitution effect + income effect

relationships between ATC and MC

-MC intersects ATC at min point

-ATC lags behind MC even more than AVC

-ATC often follows MC but lags behind bc it is an average over all units of output

-it is exactly the same as relationship between AVC and MC

demand for an input depends on:

1) value of the input: only as valuable as output it produces - Px

2) productivity of an output: amount of output produced per unit of input - MPL

sources of market failure

imperfect info

imperfect markets (lower quantity, raise prices)

externalities - cost or benefit to 3rd party

public goods - non-excludable

3 decisions made by firms

how much output to supply

how to produce that output

how much of each input to demand

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